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How the Accounting Method Changes Affect Your Small Business

Lisa G. Pileggi, CPA Director-in-Charge, Tax Strategies and Real Estate Industry Group Co-Leader

Taxpayers and their advisors ushered in 2019 eager to obtain answers to their burning tax reform questions. As part of the enactment of the Tax Cuts and Jobs Act (TCJA), the definition of a small business taxpayer was expanded, increasing the number of taxpayers that can qualify for favorable small business accounting method changes. The changes included as part of TCJA prove to be taxpayer friendly from both a tax liability perspective as well as an administrative perspective since there are fewer procedures associated with the changes.

The key component of this positive tax law change is the revision of how a small business taxpayer (SBT) is defined. Prior to tax reform, an SBT was a taxpayer with average annual gross receipts of $5 million. Thanks to TCJA, the $5 million gross receipts requirement was increased to $25 million, thereby increasing the amount of taxpayers that qualify for changes in accounting methods.

While the increase to the gross receipts test is certainly favorable and is more far-reaching than the previous law, careful consideration needs to be given to the attribution rules. The gross receipts of all organizations that are part of an affiliated group (i.e., parent-subsidiary group, brother-sister group, combined group) under common control are required to be aggregated for purposes of applying the $25 million gross receipts test.

The accounting method changes available for a small business taxpayer, listed below, generally take effect for tax years beginning after December 31, 2017:

  1. Overall Cash Method of Accounting
  2. Exemption from Uniform Capitalization (“UNICAP”) – IRC Section 263A
  3. Accounting for Inventories – IRC Section 471(c)
  4. Exemption from the Percentage-of-Completion Method of Contracts
  5. Capitalization of Costs associated with certain home construction contracts

Change: Overall Cash Method

The rules for changing from an accrual to a cash method of accounting have been modified.  This allows a small business taxpayer to change its accounting method from the accrual method to the overall cash method of accounting, assuming no additional disqualifications.

Exemption: Requirement to Capitalize Costs under Section 263A

The revision for the requirement to capitalize costs under Section 263A (UNICAP) includes the expansion to include both producers and resellers, as compared to the prior law which included resellers only. Similar to the other changes discussed, there is a gross receipts test to be applied to the taxpayer from $10 million to $25 million.

Exemption: Accounting for Inventories

The increase in the annual gross receipts requirements as part of TCJA provides an opportunity for those taxpayers that qualify to simplify their tax accounting for inventoriable costs and, in some cases, conform to the taxpayer’s applicable financial reporting or the treatment of inventory as non-incidental materials and supplies.

Exemption: Percentage of Completion for Long-Term Contracts

Generally, taxpayers must use the percentage-of-completion (PCM) method to determine taxable income under a long-term contract, with exceptions: (1) home construction contracts, or (2) construction contracts expected to be completed within two years of contract commencement. As with the previously discussed accounting method changes, the average annual gross receipts test will need to be satisfied.

There are important nuances to be considered, as there are with all things tax-related. Tax reform provides companies and their advisors an opportunity to review the current tax treatment of various items in order to determine what favorable actions should be taken.

Lisa G. Pileggi can be reached at Email or 215.441.4600.

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Lisa G. Pileggi, CPA

Lisa G. Pileggi, CPA

Director-in-Charge, Tax Strategies and Real Estate Industry Group Co-Leader

Construction Specialist, Real Estate Specialist, Business Tax Specialist, Individual Tax Specialist, Estates, Trusts, & Gifts Specialist, International Tax Specialist

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